Do your clients utilize 1099 independent contractors (ICs) who should rightly be W-2 employees? Between government audits and contractor lawsuits, this worker misclassification is becoming an ever more dangerous tightrope to walk. Even so, they may be afraid to set off IRS and U.S. Department of Labor (USDOL) red flags by reclassifying these workers properly, fearing that the fines, back wages and taxes, and other costs owed will outweigh the long-term benefits of going “legit.” The Voluntary Classification Settlement Program (VCSP), which was established in 2011 and expanded in 2013, is a great solution to this problem.
Through the program, employers who voluntarily reclassify ICs as W-2 employees are only required to repay a small portion of the back payroll taxes they owe. This significantly reduces the financial hardships that can keep employers from reclassifying employees correctly.
The employer must meet the following criteria to qualify:
- The workers they want to reclassify must have been consistently treated as non-employees in the past and must be treated as such at the time of application.
- The employer must have filed all required Forms 1099 for the applicable workers for the previous 3 years at the time of application.
- The employer cannot be be under an IRS audit regarding employment taxes (other types of IRS audits are permissible).
- The employer cannot be under USDOL or state agency audits regarding the classification of workers.
- If the IRS or the USDOL has previously audited an employer regarding the classification of the workers, they will be eligible only if they have complied with the results of that audit and are not currently contesting the classification in court.
Employers can apply for the VCSP by filling out Form 8952. If they meet the eligibility requirements, they will receive the following benefits in exchange for agreeing to treat the workers as employees for future tax periods:
- The employer will pay only 10 percent of the employment tax liability that would have been due on worker wages for the most recent tax year.
- The employer will not be liable for any interest and penalties on the amount.
- The employer will not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years.
Bottom Line
Whether or not your clients enroll in this formal program to reclassify their ICs, they should conduct an internal audit to ensure that anyone who is classified as an IC meets the IRS guidelines. Another way to help your clients is by offering to convert 1099 ICs to contractors who become W-2 employees of a contract staffing back-office. Also, if you, the recruiter, have been offering contract staffing to your clients by paying the contractors as ICs, you can conduct your own internal audit and consider using a back-office to convert these contractors to W-2 employees.
In both cases, the back-office takes on all the employment responsibilities, including paying the employer portion of taxes, administering and paying the employer portion of benefits (and complying with healthcare reform), payroll processing and funding, Workers’ Compensation, all state and federal tax withholdings, employee issues, and more. That way, the employer or the recruiter will still avoid the administrative hassles and additional costs that come with W-2 employees while removing the risk of an IRS audit.
This article is for informational purposes only and should not be construed as legal advice.
This article states nothing of the long standing ‘safe harbor’ laws that protect businesses who are being audited for potential worker misclassification. These laws drastically reduce the penalties and back taxes owed by any company found in violation, as long as certain (mainly) easily obtainable conditions are met. This is why the DOL is donning the IRS’s pants and attempting to tackle the problem by partnering with state agencies to go after businesses in potential violation of labor laws, because the IRS at present, largely has no teeth within the law. I read an article recently written by an ex-IRS employee who stated that upon forwarding potential misclassification cases to superiors, found that they were nearly always returned to him with ‘Safe Harbor’ written on the file, the proceedings going no further. The voluntary reclassification program may suit some businesses, but in the main when it comes specifically to payroll taxes, most will duke it out with any potential claimant and retreat to their ‘safe harbor’.
Hi Jim,
You bring up a great point. Historically, the Revenue Act of 1978’s Section 530 “Safe Harbor” protections have protected many large companies from realizing the full extent of potential consequences for misclassifying workers. Safe Harbor, if applicable, does limit the IRS in assessing retroactive federal employment taxes, penalties, and interest. However, the protections are limited and misclassification consequences are increasing, due in large part to the Joint Initiative between the IRS, the Department of Labor, and over half of the states. Their information-sharing policy means that if you are caught by one, you could be penalized by all that apply. When you add in the ACA minimum essential coverage requirements (in 2016, fully effective) and the penalties and fees for non-compliance, the risk companies run by hiding behind Safe Harbor protections is greater than ever before. Keep in mind that the ACA disavows Safe Harbor for the purposes of determining minimum essential coverage and penalties.
For more information on this topic, please subscribe to our free Contracting Corner newsletter here. The next issue is devoted to misclassification and goes into greater detail.
Thank you for your reply, Torie. Yes, certainly information sharing should make any company even more wary of flouting labor laws. Describing government efficacy as “the right hand doesn’t know what the left hand is doing” is becoming somewhat less accurate as Federal and local government departments find modern electronic methods of intercommunication less laborious than they were. Still, once targeted by the DOL and state authority partnership for violation of applicable labor laws concerning overtime and other benefits due to worker misclassification, I’ve not yet seen much evidence (publicity) of the IRS picking up the scent and going after these same companies for non-payment of Federal payroll taxes relating to the misclassification violation. I believe this is due in large part to the safe harbor laws that probably have little chance of amendment while, shall we politely say, a business-friendly environment exists in Washington. There have been some attempts by Democrats to introduce bills that have died in committee. All eyes are on high profile cases, like Uber, to see if they become game changers.
Hi Jim,
Thank you for you well-stated comment. I have also seen others wonder if the higher profile cases that involve the “sharing economy,” such as Uber, could disrupt the current binary system of W-2 and 1099 classification. It will be interesting to see how it all plays out in the courts over the next few years.